Coach Rides Through U.S. Storm

Profits meet expectations, though U.S. retail sales unexpectedly drop.
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Updated from 10:30 a.m. EST

SAN FRANCISCO --

Coach

(COH)

managed an 11% rise in second-quarter profits, meeting expectations, despite a drop-off in North American retail sales in the key holiday period.

The high-end purse and wallet seller, whose shares have plunged in recent months amid worries of an economic slowdown, indicated that its customers spent less in its U.S. stores, while a competitive promotional environment hit margins. Still, the company backed its profit outlook for the year and said it is poised to weather the economic woes.

For the fiscal year ending in June, Coach sees earnings of about $2.06 a share and sales of roughly $3.15 billion, in line with its prior guidance. Wall Street targets fiscal-year earnings of $2.04 a share and sales of $3.16 billion.

Christine Chen, an analyst for Needham & Co., says Coach's confidence in its guidance is somewhat surprising, as many analysts were expecting it to trim its forecast to reflect a difficult economic climate.

At the same time, Coach said it expects gross margin to fall by 100 basis points for the year as a result of continuing promotional activity, which Chen says shows that the company is being realistic about what it can achieve.

Shares of Coach recently were down 12 cents, or 0.4%, to $27.37.

Indeed, Chief Executive Lew Frankfort admitted that the road ahead would be tough.

"This quarter demonstrated for the first time in our public history that we are not immune to a slowing consumer environment," he said during a conference call with analysts.

Coach's profit for the quarter ended Dec. 29 rose to $252.3 million, or 69 cents a share, from $227.5 million, or 61 cents a share, a year earlier.

Sales climbed to $978 million from $805.6 million last year.

The results were slightly above Coach's October forecast for earnings of 68 cents a share and sales of $970 million. Analysts polled by Thomson Financial anticipated earnings of 68 cents a share and sales of $965 million.

Coach's gross margin dropped to 75.4% to 77.1%, reflecting a promotional environment in North America and currency fluctuations.

North American same-store sales, or sales at stores open at least a year, jumped 7% for the quarter. But that was buoyed by Coach's lower-priced factory stores, where comps surged 17.7%. At Coach's full-priced retail stores, same-store sales fell 1.1%.

In October, Coach had predicted a low-single-digit rise in same-store sales for its North American retail sales.

Mike Tucci, president of the company's North America division, noted that while Coach achieved a higher rate of conversion into sales at its stores, the average transaction value per purchase declined. The company also saw customers trading down to products carrying lower price points.

In an attempt to shift more customers into higher price points, Coach has begun offering limited-time discounts at its retail stores to customers who shop exclusively at the factory stores.

At the same time, Frankfort said Coach is looking to develop new products at a wider range of prices to attract a broader swath of customers.

Abroad, Coach is making noticeable gains. In Japan, where Coach has a significant presence, sales rose 17% on a constant-currency basis.

Randal Konik, an analyst for Bear Stearns, said that while even a best-in-class retailer like Coach is susceptible to broader economic concerns, it still deserves credit for its multi-channel and globally diverse business model.

"Management is demonstrating it can pull many levers to drive shareholder value," Konik wrote in a research note. "Overall, we remain cautious on all stocks near-term, but continue to like COH's long-term prospects with tremendous opportunity in emerging markets and a favorable product category."

Shares of Coach have tumbled roughly 57% since hitting a 52-week high of $54 last April as signs of a consumer slowdown mount. The shares reached an intraday 52-week low of $23.22 on Tuesday.